What is a Shareholders’ Agreement and does my business need one?
The question ‘what is a shareholders’ agreement?’ has a straightforward answer: When people set up a new business together it is usually more advantageous to set up a limited company as it limits personal liability for any debts. It is also generally better for tax purposes. This means that it is necessary to have an agreement for the different partners in the business. For more information the advantages for a business, see the basic questions we have answered below.
The need for a formal shareholders’ agreement between business partners
When people start a business, they may not even be aware of what is a shareholders’ agreement’s purpose or need. They often tend to rely on the good relationship they have with the other business partners who own shares, and see little need to put in place something as formal as a legal document. However, this approach could be the source of disputes in the future if people fall out or their objectives and ambitions change, which frequently happens.
That is why it is a very good idea to have a shareholders’ agreement. This is a contract between the owners of a company that sets out what will happen in certain circumstances and to protect each shareholder’s investment.
The departure of a member of the business
For example, what if one party wants to sell his or her shares or dies? Would the continuing shareholders want the right of first refusal over those shares; how will they be valued; where will the funds come from to purchase those shares? Without a key document then these matters will remain uncertain, could cause disputes, and that can have a massive impact on the business.
Another source of dispute is where one shareholder wants to take the profits out of the business and the other wants to invest the money to grow the business. Which shareholder would decide and how would you deal with deadlock? A shareholders’ agreement forces shareholders to deal with all of these issues in advance, without the need for conflict.
Protecting minority shareholders
Most companies work on the basis of one share one vote. Generally if one party owns more than 50%, they control the company and can veto the decisions of other shareholders. An agreement can therefore protect minority shareholders by requiring a certain majority vote on certain important business decisions.
Protecting goodwill and preventing competition from departing shareholders
A shareholders agreement can also help to protect the goodwill of the business following the exit of a key shareholder by imposing non-competition clauses. Without this, you could have a situation where one of the business owners could walk away and set up a new business without any restrictions whatsoever.
The other big advantage of a shareholders’ agreement is that it is a private contract that is not available for public viewing at Companies House unlike other documents.
The best time to get a shareholders’ agreement is at the outset, even with family and friends as co-owners of the business, because everyone will have common goals and objectives for the business and this might not be the case in the future. If you wait for the issue that the shareholders’ agreement deals with to arise it could be very difficult to do anything about it at that stage.